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Ninth Circuit Declines to Rehear Case That Creates Circuit Split on Car Loans in Bankruptcy - In re Penrod

November 9, 2011

Our Claremont consumer bankruptcy attorneys were interested to read a passionate dissent in a bankruptcy case that splits the Ninth Circuit from some of its sister circuits. In In re Marlene Penrod, the Ninth U.S. Circuit Court of Appeals voted against a full en banc rehearing of its previous three-judge decision on the way debtor Marlene Penrod's auto-loan debt should be treated in bankruptcy. Penrod traded in a car on which she was "underwater," or owed more than it was worth, to buy a new car in 2005. Penrod argued that the negative equity portion should be treated as unsecured debt in her subsequent bankruptcy, and the Ninth Circuit agreed. In their en banc vote dissent, four Ninth Circuit justices argued that this splits their court with eight others.

When Penrod traded in her old car for a brand-new one in 2005, the dealer paid off the loan and added that cost to the amount she owed. Thus, she was underwater on her car from the start. She was still underwater about a year and a half later when she filed for Chapter 13 bankruptcy. Her bankruptcy plan proposed to split off the portion of the debt that came from the negative equity and treat it as unsecured debt, while the rest of the auto loan would be secured debt. The bankruptcy court agreed over the objections of creditor AmeriFinance, and the Ninth Circuit's Bankruptcy Appellate Panel agreed. AmeriFinance appealed again.

In the original Ninth Circuit ruling, the court acknowledged that it was splitting from its sister circuits, which it said it was not doing lightly. However, it said, it was unable to interpret the relevant statute in the same way those circuits did -- which it pointed out was "over some strong dissents." The relevant section is from the 2005 amendments to the bankruptcy law; it prevents claims from being split into secured and unsecured debts if the creditor has a "purchase money security interest" securing the debt. If it is auto loan debt, the rule applies to cars purchased within 910 days of the bankruptcy filing, a test Penrod met. The Ninth decided that under California law, Penrod's debt did not meet part of the definition of a "purchase money security interest" because the "price" of the car must be an "expense incurred in acquiring rights" to the collateral -- in this case the new car. Paying off the debt on the old car does not qualify as such an expense, the Ninth found, because it was not incurred in buying the new car; just paying off the old one.

The judges dissenting from the en banc vote sharply disagreed with this. They argued that because the dealer that sold Penrod the new car incurred actual costs by paying off her old loan, that payment was part of the dealer's costs. Thus, part of the "price" she paid for the new car included the expense of paying off the old loan. Splitting the loan into secured and unsecured portions takes away the potential consequence of repossession, the dissenters said. It also noted that the decision as it stands exposes lenders and auto dealers to risks they would never agree to if not forced to by a bankruptcy court. While Penrod would have had a case before the 2005 bankruptcy law changes, the dissenters said, eight other circuits have already found that this is no longer true. Failing to take the case en banc puts the court "on the wrong end of an eight to one circuit split."

As Irvine personal bankruptcy lawyers, we would be interested in seeing a resolution of this split, so we can properly advise our clients. As things currently stand, it appears that we are free to tell California bankruptcy filers that they can split their secured and unsecured debts -- but if the Supreme Court takes up AmeriCredit's appeal, that could change. And because so many of the circuit courts have ruled the other way, the Supreme Court may very well decide that the Ninth Circuit was wrong, throwing any pending cases into potential jeopardy. As with so many other kinks in the bankruptcy code, this one stems from the 2005 bankruptcy changes, which have been criticized for being poorly written (including in the Ninth Circuit's original ruling). As Oceanside individual bankruptcy attorneys, we regret that so many of our clients' futures depend on vaguely and poorly worded statutes.

If you're deep in debt and you'd like to talk to an experienced bankruptcy lawyer about your options, don't hesitate to call Howard Law, P.C. To learn more or set up an appointment, call us today at 1-800-872-5925 or send us a message through our website.

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